Buying a home is a big decision. If you’re a first-time home buyer, you may be feeling overwhelmed by all of the options available to you. One type of loan that you may come across during your research is an FHA loan. We’ll take a closer look at what an FHA loan is and how it might benefit you as a first-time home buyer.
An Introduction to FHA Loans
An FHA loan is a mortgage that is insured by the Federal Housing Administration (FHA), a government agency that is part of the U.S. Department of Housing and Urban Development (HUD). FHA loans are available to all kinds of borrowers, including first-time home buyers with limited credit histories. This type of loan is attractive to first-time home buyers because it has more flexible lending requirements than a conventional mortgage.
FHA loans are only offered by approved lenders, however most lenders seek this approval as they are a very common loan type.
To qualify for an FHA loan, you’ll typically need to have a credit score of at least 580 and demonstrate that you have a steady income and employment history. FHA loans are not available for those with a credit score under 500.
Down payments for FHA loans can be as low as 3.5% of the purchase price of your home. Credit scores below 580 may still allow you to qualify for an FHA loan, but you’ll be required to make a larger down payment of 10%. This can vary on a lender to lender and a client by client basis, so make sure to speak with multiple lenders especially if you have a lower credit score.
FHA loans aren’t just for first time home buyers, in fact, anyone who meets the credit and income requirements can apply. Even if you have declared bankruptcy or have had a home foreclosed on in the past, you may still be eligible for an FHA loan. FHA typically only allows for you to have a single FHA loan at a time, so if you already have an FHA loan you’ll need to pay that off before taking out another. There are cases such as a job relocation or change in family size where you can apply for a “hardship” exception. In general, the FHA has these loans for your primary residence, and it isn’t to be used for second or investment homes.
What types of FHA loans are there?
There are many different types of FHA-insured home loan programs.
These include very common programs, such as:
- Adjustable-Rate Mortgages (ARMs)
- FHA Home Equity Conversion Mortgages (HECMs) – Reverse Mortgages
- Streamline Refinances
Other programs are also available to fulfill more unique needs. These include:
- Condominium Mortgages
- Disaster Victims Mortgages 203(h)
- Energy-Efficient Mortgages (EEM)
- Rehabilitation Mortgages – Section 203(k) – Rehab Loan / Renovate Loan
What Are the Benefits of an FHA Loan?
One of the biggest benefits of an FHA loan is that it can help you get into a home with less money down and a lower credit score. This can be especially helpful if you don’t have a lot saved up for a down payment. Additionally, because FHA loans are backed by the government, lenders may be more willing to work with borrowers who might not otherwise qualify for a conventional mortgage.
What additional fees are associated with an FHA loan?
FHA loans come with certain additional fees, such as mortgage insurance premiums and upfront mortgage insurance. Mortgage insurance premiums are charged monthly and will be included in your monthly mortgage payment. If you are putting 10% down or more, your mortgage insurance premium will last for 11 years. If you are putting less than 10% down, your mortgage insurance premium will last the lifetime of the loan, and the only way to remove it is to refinance your loan.
Upfront mortgage insurance is a one-time fee that is due when you close on your loan. This fee helps to insure the lender against any losses if you were to default on your loan. This fee is 1.75%, and it can either be paid out of pocket at closing, or it can be financed into your loan. Consider that you are adding 1.75% to your loan that you have to pay off that is simply insurance and doesn’t help lower your overall principle.
There are a few things that can impact your mortgage insurance costs, such as your credit score and the size of your down payment. The higher your credit score, the lower your mortgage insurance premiums will be. Additionally, the more money you put down, the lower your premiums will be. So if you’re able to save up for a larger down payment, you’ll likely end up paying less in mortgage insurance premiums.
What are the income and loan limits for an FHA loan?
There are no income limits when it comes to FHA loans. However, there are loan limits. The maximum loan amount varies depending on where you live and is based on the county of the home you are purchasing. The average loan limit in 2022 is in the mid $400k. The loan limits range for one-family properties $420,680 to $970,800, based on the cost of living. If you’re looking to purchase a higher-priced home that exceeds the FHA loan limit, you may need to apply for a conventional mortgage instead of an FHA loan or make up the difference with a larger down payment.
FHA loans also have a debt to income or DTI limit primarily based on credit score. This affects the total buying power that you have.
For credit scores between 500 and 579, the maximum DTI is 43%, if you have additional cash reserves, meaning money in the bank, this may be able to be raised to 47%. A loan officer can help you determine the exact numbers for your situation.
For credit scores 580 and above, the maximum DTI is 50%, though it does require that you have a certain amount of cash reserves, which again, is money in the bank after your loan closes.
So your credit can really affect your buying power.
What homes are eligible for an FHA loan?
Section 203(b) financing is limited to 1 to 4 unit properties that are owner-occupied and will serve as the borrower’s principal dwelling. This means that if you are using an FHA loan, then you have to live in the home. If it is a multi-unit home, like a duplex, you are allowed to rent out the other units, but still have to live in one of them.
The homes that FHA is eligible for can include detached or semi-detached properties, townhouses, row houses, individual units within FHA-approved condominiums, and manufactured housing.
Homes also have to meet HUD’s minimum property requirements (MPR) and minimum property standards (MPS). The homes must also be appraised for at least the loan amount in order to qualify for an FHA loan. An FHA approved appraiser will go onsite and create an appraisal detailing the home and its value.
Some conditions, such as standing water in the foundation or excessive damp, hazardous materials onsite, defective systems, pest infestations, or similar can cause issue with loan approvals and may require repairs to be performed before a loan can be approved.
Defective conditions: this refers to defective construction, evidence of settlement, excessive dampness, leakage, decay, termites, environmental hazards, other health and safety hazards, or issues with structural soundness.
Each property must also contain at least one of the following:
- A sufficient, continuous supply of safe, potable water with adequate pressure and quality for household use
- Sanitary facilities and safe sewage disposal; every living unit must have at least one bathroom, including at least a flush toilet, sink, and bathtub or shower
- Adequate space and heating for healthy, comfortable living conditions
- Hot water
- Sufficient electricity for lighting, cooking, and equipment necessary for living
Are there other loan options with lower down payments than an FHA loan?
Yes, there are other loan options with lower down payments than an FHA loan. For example, a conventional mortgage may require a down payment of as little as 3%. However, keep in mind that the requirements for a conventional mortgage are typically more stringent than those for an FHA loan. So you’ll need to have a higher credit score and demonstrate more consistent income and employment history to qualify. There are also USDA and VA loans, which are government-backed loan programs that may have even lower down payment requirements. USDA has income and location restrictions, while VA loans are only available to veterans, active-duty service members, and their spouses. Make sure to ask about different loan options and compare the requirements to find the best fit for your needs.
Other types of FHA loans
ARMs are held to many of the same standards as already described for other FHA loans, including borrower qualifications and property conditions. FHA ARMs may feature an initial fixed-rate period of one, three, five, seven, or ten years, followed by annual interest rate adjustments. Rate caps are in place to influence the interest rate adjustments, and the caps vary based on the length of the initial fixed-rate period.
ARM loans are often a good choice if you know you will not be living in the home for more than the initial fixed rate period, or if you are comfortable with a much higher loan payment after an initially lower payment.
Section 203(k) Rehab Loans
The 203(k) program allows the borrower to purchase or refinance a home that is in need of rehabilitation or renovation and to include the improvement costs in the principal amount.
A 203(k) loan might be used for:
- Structural changes, including converting a single-family home to a multifamily home or multifamily to single-family
- Modernization or functional improvements
- Elimination of health and safety hazards
- Reconditioning, replacement, or installation of plumbing or well/septic systems
- Roofing, gutters, and floor work
- Significant landscaping or site changes
- Accessibility for persons with disabilities
- Improvements for energy conservation/efficiency
Borrowers who are already in the home they wish to renovate can also obtain a refinance through the 203(k) program
Repairs or remodeling minimums are $5,000. Funding cannot be used to build a new swimming pool, but can be used to repair an existing one. Repair work is also typically limited to 6 months. One really nice aspect is that borrowers may complete their own renovation work, however they cannot be paid for their labor time.
Home Equity Conversion Mortgage (HECM) Program – Reverse Mortgage
Reverse mortgages allow consumers of a qualifying age to draw on the equity they have built up in their homes. Rather than making payments to a lender over time, reverse mortgage borrowers receive payments from a lender. There are specific requirements:
- Be 62 years old or older
- Own the property completely or have paid down a considerable amount of the mortgage
- Occupy the property as a principal residence
- Not be delinquent on any federal debt
A reverse mortgage is not normally something a first time homebuyer needs to think about, but knowing what programs are available when you reach retirement age and have paid down or paid off your home is valuable knowledge to have. In fact, you might actually be looking to purchase a home that has a reverse mortgage on it, but not to worry, as a buyer you shouldn’t have to worry about the types of loans used on the home.
Purchasing a home is a major financial decision, so it’s important to educate yourself on all of your options before committing to anything. If you’re looking for a type of loan that has more flexible requirements, an FHA loan might be right for you. With an FHA loan, you could potentially qualify for a mortgage with a lower credit score and down payment than you would with a conventional mortgage. As always, be sure to speak with multiple lenders to compare your different loan options and find the best fit for your needs.